*This writing is a blog post. It is not a published IPTF Journal article.
Mira Ward
Augmented reality, virtual reality, and decentralized finance are the essential building blocks of Web3, the third generation of the internet.[1] Intuitively, Web3 is the successor of Web1 and Web2.[2] Web1 refers to the earliest phase of the internet, a set of non-interactive sites aimed at content consumption rather than creation.[3] Web2 allowed for content creation and user interaction.[4] Web3 offers a decentralized, borderless online economy where users can own and trade assets.[5] The decentralized nature of Web3, the Metaverse, and encrypted transactions raises numerous questions about when, where, and how claimants can establish personal jurisdiction in claims arising out of Web3 transactions.[6] Ultimately, the current jurisdictional framework for Web2 markets is incompatible with Web3 transactions.[7]
Blockchain technology is the backbone of Web3 programming. Blockchain is a database management system (DBMS) comprising a growing string of encrypted transactions, or “blocks.”[8] These blocks are recorded on a public, digital ledger.[9] One type of blockchain network is a Decentralized Autonomous Organization, or “DAO.”[10] DAOs are unincorporated governance systems operated by its network participants; DAO marketplaces allow network participants to buy, sell, and trade cryptocurrency and other encrypted assets like NFTs.[11] Each transaction on a DAO must be approved by other network participants through “smart contracts” (a type of encrypted, digital agreement) and must follow a set of agreed upon community guidelines.[12]
There is no clear legal framework for establishing personal jurisdiction in Web3 marketplace disputes, as jurisdictional issues surrounding cryptocurrency disputes have generally been limited to Web2 platforms.[13] In claims brought in the US, whether a court has jurisdiction over a case depends on the sufficiency of a claimant’s contacts within a given state.[14] For example, In Herbal Brands, Inc. v. Photoplaza, a health and wellness brand (Herbal Brands, Inc.) principally operated out of Arizona filed suit in Arizona against another company (Photoplaza) for selling Herbal Brands’ products to customers in New York through an Amazon storefront without authorization from Herbal.[15] Photoplaza moved to dismiss the case for lack of personal jurisdiction but the court denied Photoplaza’s motion to dismiss, reasoning that Photoplaza had established the requisite minimum contacts with the state of Arizona by way of intentionally selling a physical good through an interactive website available to all 50 states.[16]
The court in Herbal Brands follows the Calder Effects Test, a traditional test for establishing personal jurisdiction for Web2 storefronts.[17] The Calder Test centers around “whether the defendant: “(1) committed an intentional act, (2) expressly aimed at the forum state, (3) causing harm that the defendant knows is likely to be suffered in the forum state.”[18] When puzzling over the jurisdictional questions posed by online storefronts, Attorney and legal scholar Benjamin Spencer discourages an internet-specific approach to establishing personal jurisdiction in virtual claims.[19] Building from traditional frameworks like The Calder Test, Spencer proposes the following adjusted test: “A state may, consistent with due process, exercise judicial power over a person outside of the State when that person (1) purposefully directs activity into the state via virtual networks; (2) that activity gives rise to, in a person within the State, a potential cause of action cognizable in the State’s courts; and (3) the assertion of jurisdiction is constitutionally reasonable.”[20]
The first prong of Spencer’s test aims to solve the limitations of the Calder Test, but is unfortunately incompatible with claims arising out of Web3 DAO transactions.[21] If criminal activity or intellectual property infringement takes place through a DAO transaction, the potential liability of each network participant is uncertain.[22] DAOs are often categorized as general partnerships, opening each member in the DAO network to “potentially…unlimited legal liability if something goes wrong.”[23] If Spencer’s test is applied to Web3 claims, the first prong could make every node in a blockchain network vulnerable to legal claims since each transaction must be approved by other nodes in the network via smart contracts and community guidelines called social consensus constitutions.[24] According to capital market legal theorists Aneta Napieralska and Przemysław Kępczyński, the architecture of blockchain leaves DAO participants vulnerable because by simply validating a smart contract, a network participant becomes a “but-for” cause of any tortious act committed through a DAO transaction.[25]
A new framework to accommodate Web3 networks and protect relatively innocent network participants in blockchain ecosystems in the Metaverse, albeit prospectively, is needed.[26]
[1] Winston Ma & Ken Huang, Blockchain and Web3: Building the Cryptocurrency, Privacy and Security Foundations of the Metaverse, John Wiley & Sons, Inc. (Nov. 11, 2024) (downloaded using Spotify).
[2] See id.
[3] Graham Cormode, & Balachander Krishnamurthy, Key differences between Web 1.0 and Web 2.0, AT&T Labs Research (November 20, 2024), https://doi.org/10.5210/fm.v13i6.2125.
[4] See id. (drawing a distinction between non-interactive first internet generation and interactive second internet generation).
[5] See Ma & Huang, supra note 1 (highlighting Web3’s emerging role in encrypted asset trading).
[6] See id.
[7] See Benjamin Spencer, Jurisdiction and the Internet: Returning to Traditional Principles to Analyze Network-Mediated Contacts, University of Illinois Law Review 113, 71-126 (2006).
[8] See Ma & Huang, supra note 1 (explaining the architecture of blockchain technology).
[9] Id.
[10] See Matthew R. McGuire, The Internet, Personal Jurisdiction, and DAOs, 80 Wash & Lee L. Rev. 1217, 1220 (2023) (overviewing the infrastructure of DAOs and their potential role in the Metaverse).
[11] Id.
[12] See Ma & Huang, supra note 1 (describing the validation process for DAO transactions).
[13] See McGuire supra note 10.
[14] See Herbal Brands, Inc. v. Photoplaza, Inc., 72 F.4th 1085, 1085 (9th Cir. 2023) (introducing the primary test used to establish personal jurisdiction over the defendant, Photoplaza).
[15] See id.
[16] See id.
[17] See id.
[18] See id. at 1091 (outlining each step of the Calder Test).
[19] See Spencer supra note 6.
[20] Id. at 73.
[21] See id.
[22] See McGuire supra note 10 (describing issues arising with the third generation of the internet).
[23] See Spencer supra note 16.
[24] See Becky Powell, Regulating the Unregulatable: The Digital Commodity Exchange Act’s Use Based Approach to Cryptocurrency Regulation, B.C. Intell. Prop. & Tech. F. 1, 24 (July 28, 2021), http://bciptf.org/2021/07/regulating-the-unregulatable/.
[25] See Napieralska and Kępczyński supra notę 147 (arguing that signing smart contract is enough to imply causation in a negligence claim).
[26] See id.